Is Executive compensation deductible?
Tax would be low when your corporation has so many expenses compered to its sales. But some of the expenses are not deductible and executive compensation is one of them you have to know.
What is Executive compensation?
Salaries and bonuses (and other benefits) that a company pay to their representative director, director, auditor, inspector, managing member, and any other person (e.g. adviser) who performs a policy making function.
Some employees are deemed executives
Employees work in a family corporation*, and if they perform a policy making function and own certain percentage of their company’s stock, they are deemed executives.
*Family corporation is a corporation whose three or less of shareholders own more than 50% of the stock. Thus family corporation could be controlled by small number of individuals or corporations, and special tax rules can be applied.
Some executives are deemed employees
Executives (under companies act) who actually work as an employee and do not own certain percentage of their company’s stock could be employees (Executive compensation rule does not apply). However, representative director and other similar officers cannot be deemed employees.
Deductibility of executive compensation
Below compensation is usually deductible.
- Periodic fixed amount compensation
- Executive compensation is deductible when same amount of compensation is paid regularly (usually monthly)
- Compensation reported in advance
- Executive compensation is deductible when you have submitted ‘report on compensation paid to executives’ to your tax office in advance. You can think about this when you pay bonuses.
- Performance-based compensation
- Executive compensation is deductible when you basically meet the below requirements.
- Compensation is calculated on the basis of company’s performance indicators (e.g. profit) and paid to managing members (performing operations).
- Appropriate procedure is taken by certain committee (relating to compensation)
- Recognized as expense
- Non-family corporation or family corporation perfectly controlled by non-family corporation
Unreasonably high executive compensation is not deductible
- Executive compensation would be unreasonably high if it is more than the amount determined by company’s articles of incorporation or the shareholders’ meeting.
- Executive compensation could be considered as unreasonably high by considering executives’ duties, company’s sales, employees’ salaries, and executive compensation of other companies in the same (or similar) industry.
Unreasonably high employees compensation is not deductible
- Certain employees’ (a relative of the executives or a person financially supported by the executives) compensation would be considered as executive compensation, and not deductible when it is unreasonably high.
Unreasonably high retirement allowances for executives are not deductible
- Retirement allowances for executives are basically deductible.
- The retirement allowance could be considered as unreasonably high by considering tenure of executives, reason behind the retirement, and retirement allowances of other companies in the same (or similar) industry.
- Below formula is usually used to determine the deductible limit (not a perfect formula. But widely used.).
- Monthly salary (at the time of retirement) × Years of service × Credit ratio* = deductible limit
- *you can determine and it depends on executives. The maximum is ‘usually’ three.